If you are a business owner, whether big or small, the Internal Revenue Service has issued final regulations that will impact your business in 2014 and beyond. These new regulations provide guidelines and safe harbors in relation to capitalization of certain expenditures. They are split into two areas: (1) Materials and Supplies and (2) Repairs.
Materials and Supplies
The final regulations allow all businesses to deduct units of property when purchased if they are consumed in less than 12 months or have an acquisition cost of less than $200. This would apply to common supplies such as napkins for a restaurant or towels for a hotel. It would also apply to some items that are not normally considered supplies, such as televisions, computer monitors, file cabinets, office furniture, etc. One exception to this rule applies to items that are being tracked and counted like inventory. These types of items must be deducted when used or consumed rather than when purchased.
Any purchased item that fits the above definitions can be expensed rather than capitalized and depreciated. This is especially important with the $25,000 limit on Section 179 expensing for capital assets currently effective for 2014 and future years.
The final regulations also add a de minimis safe harbor election for businesses that would like to deduct units of property with a purchase price greater than $200. The deduction limits depend on whether or not the business has an Applicable Financial Statement (AFS). A business has an AFS if their financial statements are audited, issues them to the SEC, or issues them to another federal, state, or local governmental body.
If a business does not have an AFS, the business can put in place an accounting procedure (we recommend written) by the beginning of the tax year that allows for expensing of items with a useful life of less than 12 months or costing less than an amount up to $500. This accounting procedure needs to be followed for book purposes and tax purposes to meet the safe harbor.
If a company has an AFS, the business can put in place an accounting procedure that must be in writing by the beginning of the tax year that allows for expensing of items with a useful life of less than 12 months or costing less than $5,000. This accounting procedure needs to be followed for book purposes and tax purposes to meet the safe harbor.
The above expensing limits apply per item/unit of property if substantiated on an invoice. Here is an example: ABC Company purchases 100 computers for $400 each. The business does not have an AFS and has an accounting policy of $500. The business pays the $40,000 invoice and expenses the computers as supplies.
As you can imagine, this will change the way one looks at purchases of items that might have been capitalized in the past and now can be expensed as supplies.
In our spring 2013 newsletter, we went into great detail about the proposed regulations that were issued on this topic. The final regulations are very similar and here is a brief overview.
The regulations do not give a safe harbor dollar amount. They do give three tests to decide if an item should be capitalized or expensed. The rules are very detailed and in-depth and cannot be covered in detail in this newsletter. However, here is a quick summary of some of the definitions for your reference. If a transaction falls into one of these three categories it must be capitalized for tax purposes.
Betterment corrects a material defect that existed prior to acquisition, increases the size or capacity of the item or materially increases the strength, efficiency, quality or output of a unit of property. Example – Remodeling of a retail store.
Adaptation is the modification of a Unit of Property to a new or different use that is inconsistent with the original use. Example – Conversion of a manufacturing building into a retail showroom.
Restoration is returning a unit of property to its ordinarily efficient condition if the property has deteriorated to a state of disrepair. Example – Running an engine until it is not operational and then having to over haul it.
Again, these are just a few of the definitions related to repair transaction that would result in a business being required to capitalize the expenditure. Each transaction needs to be evaluated and any sizable transactions should be discussed with your tax professional.